Crowdfunding Is Not a Scam, It's Market Research

Virginia Postrel is a Bloomberg View columnist. She was the editor of Reason magazine and a columnist for the Wall Street Journal, the Atlantic, the New York Times and Forbes. Her books include “The Power of Glamour” and “The Future and Its Enemies.”
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Crowdfunding sites such as Kickstarter and Indiegogo represent a classic entrepreneurial phenomenon: Once you roll out your great idea, customers use it in ways you didn't imagine, and you wind up in a different business than you expected.

Kickstarter's founders wanted to help artists raise money. Indiegogo co-founder Danae Ringelmann pictured aiding capital-strapped small-businesses owners like her parents. Neither intended their site to act as a test market. But, as the rags-to-riches story of virtual-reality firm Oculus shows, that's what they have become.

"It's a way to access capital, but what it's also become is a market-testing and validation platform," Ringelmann told the Dent the Future conference on Tuesday. "What we're doing is creating pre-markets for ideas," she said.

In theory, the sites operate a bit like a PBS pledge drive: Give us money for a good cause and we'll send you this nifty tote-bag. But the economics of running a campaign work best if whatever you're trying to do directly generates the premium. That way the same cash you use to complete your project gives you products or event tickets to hand out.

"If a project's goal is to produce a pure 'public good' -- like data, as it was in my case -- almost any exclusive, tangible reward offered to backers winds up simply adding costs, making it that much harder to raise the required funds," says Cosmo Wenman, who ran an unsuccessful Kickstarter campaign to finance 3-D scans of classic sculptures. "The tote-bag is not free." (He instead received funding from Autodesk.)

As a result, the most successful crowdfunding projects aren't charities. They're ventures that produce something people wish they could buy.

That makes crowdfunding a great way to test the market. "You're going directly to your fans, your customers, the people who're going to be your customers," said Ringelmann. You're finding out whether anyone is willing to pay for your great new idea.

When more than 9,500 people gave $2.4 million -- nearly 10 times the original goal -- to back the Oculus Rift headset on Kickstarter, it was clear the market was hungry for the invention. Although smaller donors received T-shirts or posters, the vast majority contributed enough to get either a prototype or a developer kit.

Now that Facebook is buying Oculus for $2 billion, critics are reverting to the original assumption that crowdfunding is primarily about raising money. "Talking people out of $2.4 million in exchange for zero percent equity is a perfectly legal scam," wrote my colleague Barry Ritholtz.

But it's not a scam at all. It's market research. In effect, customers placed pre-orders and received early products; why are they griping that they don't own a part of the business?

The backlash is largely Kickstarter's fault. It may not be running a scam, but it definitely sends mixed messages. Unlike Indiegogo, which prides itself on operating a neutral platform giving anybody's idea a market test, Kickstarter hasn't embraced its de facto transformation. It strictly curates the campaigns it hosts and, although it makes its biggest profits on technology products, it still exudes an artistic sensibility that isn't entirely comfortable with disruptive technology or large enterprises. It still talks as though it's PBS. "Kickstarter is not a store," it declares.

Indiegogo, by contrast, proudly touts itself as testing platform. "We allow entrepreneurs to prove themselves in a merit-based way," by discovering whether a venture can in fact attract interest and money from potential customers, said Ringelmann. The site even allows campaigns to swap in new perks or change the required giving levels. "You can test your pricing. You can test your features," she said. That kind of blunt sales-oriented language would be unheard of on Kickstarter.

Crowdfunding has enormous potential to expand entrepreneurial opportunity and reduce business risks. "We've actually gotten thank you notes," said Ringelmann, "from people who were highly unsuccessful in raising money that said, 'In three weeks I discovered that I had an idea that nobody wanted. You just saved me two years of my life.'"

But these benefits depend on recognizing this new institution for what it is: a way of taking pre-orders, not a charity pledge drive.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

(Virginia Postrel is a Bloomberg View columnist. Her book, “The Power of Glamour,” was recently published by Simon & Schuster. Her website is at vpostrel.com. Follow her on Twitter @vpostrel.)

Virginia Postrel is a Bloomberg View columnist. She was the editor of Reason magazine and a columnist for the Wall Street Journal, the Atlantic, the New York Times and Forbes. Her books include “The Power of Glamour” and “The Future and Its Enemies.”
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